Inflation exceeded 5 percent last month according to the CSO – the highest annual rate since 2007. What are we to make of this and what are we to do? While high rates of inflation can be economically corrosive and usually result in real pay cuts, the primary instrument to rein in inflation – interest rates – can undermine economic growth, business activity and household living standards. The wrong use of interest rates can prolong a recession, as happened when the ECB increased interest rates in 2011, or can even brutalise a country such as what happened in the US in the 1970s. So before we get into a conversation around what we do about inflation, we need to discuss what we are to make of this latest data.
Inflation, until last year, was stable and low.
Between 2012 and 2016 inflation was flat. It picked up until 2019 but only by 2 percent which was notable given the growth in employment and wages. It fell in 2020 owing to the impact of the pandemic. But in the last year inflation has shot up by 5.1 percent.
However, we should view the 2021 outcome with the 2020 downturn – to see if we are in a bounce-back territory. Between 2019 and 2021 inflation rose by 3.6 percent. This averages out at 1.8 percent over the two years. While this is high when with the average annual increase between 2016 and 2019 (0.7 percent) it is not, yet, crisis territory.
So what has been driving inflation in the last year? Is it sector specific or more generalised? Here is a breakdown of the largest contributors to inflation over the last year.
Over 70 percent of inflation over the last two years has been driven by transport and energy products – essentially, fossil fuels. Energy products and diesel increased by 26 percent last year. But food and miscellaneous services increased by less than 0.5 percent. Restaurants and hotels increased by 4.4 percent but we could be seeing businesses trying to recoup some of their pandemic losses.
Are the increases in inflation – especially in energy products and transport – permanent or temporary? Forecasting is not a science but both the Irish Central Bank and the ECB are confident it is only temporary, a perfect storm of energy supply issues, disrupted supply chains and a bounce-back after a deflationary 2020.
And we should be thankful for their confidence. The last thing we need is for central bankers to start contemplating an interest rate rise. This could derail recovery. It should be remembered that just prior to the pandemic the Eurozone was flirting with another recession (Eurozone growth fell from 3.1 percent in 2017 4th quarter to 1.2 percent on 2019 4th quarter) while Irish growth was slowing down.
Nonetheless, the rise in energy products is particularly concerning coming into the winter, with its impact on low-average income earners as well as the business sector. Are we powerless in the face of this inflationary spike?
The usual macro-economic tools to counter inflation take demand out of the economy. This can be achieved through higher interest rates, increased taxation or reduced public spending. In such circumstances, unemployment results. This is the usual orthodox perspective: trading off inflation with unemployment. However, it is difficult to see any of these working with an inflation that is driven by energy products. In any event, these can be highly inefficient tools resulting in considerable economic and social damage.
No, we are not powerless. It is time we consider price controls and to start treating energy as a public good. This will be the subject of the next post.
Comments